Friday, May 09, 2008

AIG Clarity Challenged

American International Group (AIG) released its results and told the world the weak U.S. housing market, the disruption in the credit markets, as well as equity market volatility are responsible for some very bad returns for the investors.

Then read this quote “AIG emphasized that despite the difficult environment and its resulting effect on AIG's overall financial performance for the first quarter, core insurance businesses continue to perform satisfactorily. AIG is confident that, although present economic conditions are difficult, AIG's unmatched competitive advantages, strong brand, and unmatched global franchise position it extremely well for the future.”

AIG basically told the world that it has lots tremendous amounts of hard earned wealth. Commenting on first quarter 2008 results, AIG President and Chief Executive Officer Martin J. Sullivan said, "AIG's results do not reflect the underlying strengths and potential of AIG; rather they reflect the extremely adverse external conditions affecting the spectrum of companies exposed to the U.S. residential housing, credit and capital markets.

In the same press release they informed the world that they plan to raise approximately $12.5 billion in capital to fortify its balance sheet and provide increased financial flexibility. The capital is to be raised through a common stock offering and an equity-linked offering for an aggregate of approximately $7.5 billion. At a later date AIG also expects to issue high equity content fixed income securities.

In a separate press release they announced a 10% dividend increase which gives the impression of financial strength. They can now boast 23 consecutive years of increasing dividends. Strangely enough the dividend is payable in Sep 2008. That’s about five months into the future. Most boards announce dividends by the quarter not almost a half year in advance.

AIG has to go to markets and raise capital. Not really surprising under the circumstances. The problem is when you have cap in hand you need to look and sound good; or so management thinks.

Thursday, May 08, 2008

American States Water Gets Thirsty For Profit

American States Water Company (AWR) reported a 33% decrease in EPS. This company is supposedly a utility that delivers water to some of the most parched areas of the United States. Should be like shooting fish in a barrel. How can you drop the ball by 33%? How can management issue a press release and just mechanically review the various inputs and not comment on the drastic reduction in profitability? Hello is the executive suite awake.

The main culprit seems to be a decline in water consumption. Read this quote from the press release:

“An 8.1% decrease in water consumption during the first quarter of 2008 resulted in a $2.6 million decrease in water revenues, or $0.06 per share. The 2007 first quarter results benefited from lower than average precipitation.”

This point is approximately 60% of the decrease in EPS. The remainder of the press release goes on to ignore the issue and deal with many other details which just do not have the same impact. The executive is hiding the problem in plain sight and hoping it will be ignored.

A further issue is the change in construction expenses. Read this quote:

“For the three months ended March 31, 2008, construction expenses decreased to $3.9 million compared to $9.1 million for the same period in 2007 primarily reflecting the costs incurred in 2007 for the wastewater expansion project at Fort Bliss. There was no similar project in the first quarter of 2008.”

For some reason the construction costs could not be capitalized last year. This, from an infrastructure company that invests in pipes and pumps. But the reality is that construction costs are lower by about $6 million which should be a good thing.

It seems that this is a flush quarter where management is getting rid of some impurities. Investors can tolerate a few transitional quarters if there is a set up for the future. But they need to be brought into the loop if this is to be the case.

Wednesday, May 07, 2008

Orbitz Business Model Crashes

Orbitz (OWW)announced net revenues are up 3% and international bookings rose by 41%. You would expect good news at the bottom line. The losses increased by 50%. Q1 loss came to $15 million. Steven Barnhart, CEO and president of Orbitz Worldwide said “that that the first quarter of 2008 would be a difficult comparison against a very strong 2007 first quarter,"Steven you lost $10 million dollars last year in Q1; that cannot be characterized as strong.

The press release leads with lots of hyperbole about enhancements to the web site that will be supported by an advertising campaign. Management is excited that both top line and bottom line results will be highly rewarding.

The credibility question becomes how will the web site changes be leveraged? They already have experienced an increase in international bookings by 41%. The results were increased losses. So the statement that increased functionality on the web site will shortly equal better results is somewhat suspicious.

Tuesday, May 06, 2008

RR Donnelley Q1 Shrinking Margins

RR Donnelley reports its Q1 results. Thomas J. Quinlan III, RR Donnelley's President and Chief Executive Officer said “We are pleased with our first-quarter performance.... Our prudent capital management, our ability to leverage capacity at newly acquired companies and our focus on cost control allow us to reaffirm our stated operating target for full-year non-GAAP operating margin of slightly greater than 10.0%."

The press release went on to discuss how recent acquisitions all had lower historical margins. Read these excerpts:

U.S. Print and Related Services.... ‘the benefit of productivity efforts was offset by the inclusion of the acquired companies that in aggregate carried a lower operating margin historically.”

Net sales for the International segment... “non-GAAP operating margin decreased to 6.8% in the first quarter of 2008 from 8.1% in the first quarter of 2007 due to changes in foreign exchange rates, an unfavourable business mix and continued price pressure.” That’s margin pressure.

It appears that the recent acquisitions have driven margins downward to the point where they are affecting overall corporate performance. The President and CEO is making some very boldfaced comments that they feel confident in their ability to leverage capacity and effect cost controls. This means improved profit margins. The financial jury is still out as to whether they will be able to improve margins.

Thomas Quinlan is giving himself some wiggle room by stating the margin goal is slightly better than 10% when many of their existing businesses have historically operated at margins well in excess of 10%.

Lots of pigeons need to come home to roost to skate this one onside. So far Q1 is not a successful quarter for margins.

Monday, May 05, 2008

Berkshire Hathaway’s Conflicted Transparency

Berkshire Hathaway (BRK-A) reported its Q1 results last Friday after market close. Berkshire Hathaway is a unique combination of sophisticated complexity with a disarming transparency. No other company has ever come out and said their own press release does not contain enough information. Read this quote from the first paragraph.

“The limited information that follows in this press release is not adequate for making an informed investment judgment.”

No one else in the investing world has the “Balls” and credibility to make this work. The statement is as much a criticism of financial regulations regarding disclosure as it is a caution to investors who may be too lazy to read and truly think about all the issues.

Essentially Charlie Munger and Warren Buffett are focused on long term growth and capital formation. (Even if they do refer to themselves in the first person). They refuse to be swayed by short term quarterly results. While they are uber icons in their own right they are not the only business leaders who have plentiful credibility. Too many other CEO’s get caught up in the quarterly earnings game and disappear into the maze of accounting peculiarities needed to look good. Then the explanations become too overworked to be useful.

While Warren Buffett and Charlie Munger have clearly created tremendous wealth perhaps their real legacy will be straight simple talk.